Governments may take several policy measures to influence the movement of the economy of a country in the desired direction. Its decision depends on whether such an economy is in recession or expansion. One such way is the use of fiscal policy, which Hansen (2018) describes as the set of regulatory measures that are intended to influence the government spending and revenue collection (through taxation) as a means of either jump starting activities in the economy or to slow them down. Any one of these situations may arise, allowing for the use of fiscal policies to influence the levels of aggregate demand and to also affect aggregate supply as need be. In essence, fiscal policies can be expansionary and meant to spur economic activity, in which case tax cuts and increased government spending are considered (Hsing, 2019). The policies could also be contractionary, meant to depress economic activity and curb undesired effects, therefore. In such regard, the economy would witness increased taxation and reduced government spending (Fatas, 2019). Whichever option chosen, depending on the prevailing situation, the fiscal policies influence the economy because they affect both aggregate demand and supply. Therefore, the fiscal policy chosen by governments affects aggregate demand and supply in an economy.
Fiscal Policy and Aggregate Demand
Hansen (2018) defines aggregate demand as the total amount of goods and services demanded by the consumers within an economy at a particular price level. That is, aggregate demand connotes the ability and willingness of consumers within an economy, to purchase goods and services at specific price levels. Fiscal policy can, therefore, influence the extent to which consumers are willing to purchase commodities within an economy at given price levels. For instance, where the government adopts a contractionary approach to fiscal policy, the taxation levels would be raised, leaving consumers with comparatively lower disposable income. As a result, the consumers would be less willing to purchase any commodity at the prevailing prices due to lower purchasing ability. Similarly, this can be achieved by reducing government spending, thus depressing the overall flow of money in the economy. With little money to spur economic activity, the willingness and ability of consumers to purchase commodities within eh economy would be reduced.
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On the other hand, expansionary fiscal policies would involve the government taking measures to expand the economy through either reducing taxation levels or increasing the public spending therein (Fatás, 2019). Where governments take measures to reduce taxation levels, individuals would be left with higher levels of disposable incomes thus would be more willing and able to purchase commodities at the reigning price levels. Similarly, increasing government spending would increase the flow of money in the economy, thus spurring improvement in the willingness and ability of consumers to purchase commodities at the prevailing prices within the economy.
Fiscal Policy and Aggregate Supply
Das (2016) defines aggregate supply as the total values of goods and services produced within an economy at a given time and specific prevailing price levels. That is, aggregate supply connotes the total value of commodities that suppliers are willing to avail to the market at prevailing prices. The government may either take expansionary of contractionary fiscal measures in its economic intervention. In instances where the government takes expansionary measures, the taxation levels within the economy would be reduced. As a result, producers would witness a reduction in their costs of production, thus supplying more commodities at given price levels. Similarly, the increase in government spending would increase the demand for commodities within the economy, thereby influencing an increase in supply (Hsing, 2019).
Should governments take contractionary fiscal measures, the levels of taxation would increase, thus leading to higher costs of production for suppliers in the economy. Resultantly, producers would be less willing to supply the same amount of commodities at the reigning price levels. They would thus avail fewer goods and services to the market due to higher costs realized per unit during production. Just as much, the reduction in government spending would also reduce the total quantity of goods and services demanded in the economy (Polat & Polat, 2019). Producers and suppliers would then opt to avail less of goods and services at given price levels because of the reduction in demand for such commodities.
Conclusion
Fiscal policies refer to the measures taken by the government. The measures either influences the growth of the economy or effects a slow-down in a given growth rate. The policy tools used to achieve such an end are taxation and government spending. Should the government wish to expand economic activities, it would be well served using expansionary policies that include the reduction in taxation levels, or increasing government spending. Reduction in taxation has the effect of increasing the disposable incomes of consumers and reducing the costs of production for suppliers. Increasing the levels of government spending, on the other hand, would increase the demand levels in the economy. By comparison, the contractionary policy would have the effect of reducing government expenditure and increasing taxation levels. Reduction in government expenditure would reduce overall demand levels in the economy. In contrast, an increase in taxation would reduce the disposable incomes of consumers as well as increase the costs of production for suppliers.
References
Das, S. K. (2016). Contractionary Fiscal Policy and Public Investment. Cengage Learning
Fatás, A. (2019). Fiscal Policy, Potential Output, and the Shifting Goalposts. IMF Economic Review , 67 (3), 684-702.
Hansen, A. H. (2018). Monetary Theory and Fiscal Policy . Pickle Partners Publishing.
Hsing, Y. (2019). Is Expansionary Fiscal and Monetary Policy Effective in Australia? The Journal of Business, Economics, and Environmental Studies (JBEES) , 9 (3), 5-9. https://doi.org/ 10.13106/ jbees .2019
Polat, G. E., & Polat, O. (2019). A Discussion on Fiscal Policies Implemented in EU During and After the Great Recession. In Global Challenges in Public Finance and International Relations. (pp. 143-159). IGI Global.
